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Explaining US Inequality Exceptionalism

May 4, 2015 5:06 pmMay 4, 2015 5:06 pm

Disposable income in the United States is more unequally distributed than in most other advanced countries. But why? The answer to that question has important implications for our understanding of inequality more generally,
and also for policies intended to reduce inequality. And new work by my colleagues Janet Gornick and Branko Milanovic at the CUNY Graduate Center’s Luxembourg Income Study Center shed light on the question,
partly overturning what all of us believed until recently. They explain their findings in the first Research Brief in a new series launched on the LIS Center website.

The standard story up until now has been that the source of US inequality exceptionalism lies in the unusually low amount of redistribution we do through our tax and transfer system. Figure 1, based on LIS data, shows
Gini coefficients before and after taxes and transfers for a number of advanced economies. The US after-tax-after-transfer Gini is the highest of the group, but its pre-tax-pre-transfer Gini – the inequality
of market income – isn’t all that special. What this figure suggests, then, is that it’s all about redistribution rather than about market inequality.

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But can this be right? We know that the US has unusually weak unions, a low minimum wage, an exceptionally wide skills premium and, of course, an exceptionally imperial one percent. Shouldn’t all this leave some
mark on market income?

What Gornick and Milanovic realized (helped by suggestions from a number of colleagues, notably Larry Mishel at EPI) was that true US market inequality might be being masked by another exceptional piece of the US system
– delayed retirement, causing many older households to have positive market income where comparable households in other countries have no or very little market income. Thus, putting all households together
and looking at their pre-tax-pre-transfer income inequality makes other countries’ distributions appear comparatively more unequal because people in other countries are more likely to retire earlier than
in the US (and hence have zero or low market income).

To correct for this possible problem, they recalculated the numbers for households containing only persons under age 60, getting Figure 2. The US remains the most unequal nation (after taxes and transfers), but now
a main driver of that inequality is market inequality. In this figure, the US (along with Ireland and the UK) has market income inequality substantially higher than the rest of the countries. In other words, it
is the distribution of wages and income from capital, independent of the fiscal system, that makes the US comparatively unequal. Indeed, America also does less redistribution than several other rich countries, European
countries in particular, so that’s still part of the story, but it’s not the whole story or even most of it.

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This result has strong relevance to policy debates. There has been considerable discussion lately of the “new” conventional wisdom on labor which
argues that interventions to strengthen workers’ bargaining power can reduce inequality and raise wages with little or no damage to the economy. If it were really true that all international differences in
inequality were due to after-market, tax-and-transfer interventions, this would cast doubt on the new view. But it turns out that market income distributions differ quite a lot – and the US emerges as among
the most unequal.